“There are many routes to success and any one of them can work if it suits you. The road to hell, in contrast, is well sign-posted and well travelled. The ways to win are many and unpredictable, but the ways to lose are fewer and entirely predictable. Whichever ladder you climb, you will need to steer clear of the same snakes,” he wrote in his book
Selecting shares that perform.
Richard Koch is a former management consultant, entrepreneur, and a renowned author. Koch has also used his investment strategy to make a fortune from several private equity investments made personally. Previously, he had been a manager at
Consulting Group and later a partner at Bain and Company, before leaving to start management consulting firm LEK Consulting with Jim Lawrence and Iain Evans.
He was educated at the universities of Pennsylvania and Oxford. Koch is the author of more than 20 books, including the bestsellers
The 80/20 Principle and
The Financial Times Guide to Selecting shares that perform. He is also a successful investor and entrepreneur, with ventures including Filofax, Belgo, Plymouth Gin and Betfair.
Rules to stop losing the investment battle
With his years of experience in the investment industry Koch wrote certain guidelines in his book to help avoid the unnecessary mistakes made by investors. Let’s take a look at some of these investment guidelines.
Never invest funds you don’t own
Koch says even if investors are able to, they should not borrow money to make equity investments.
“However wealthy you are, don’t do it. It has ruined millionaires and billionaires. Don’t let it ruin you. The only thing to invest is money that you own which is not needed for any other purpose. There must be no exceptions to this rule,” he says.
Choose short-term investments with great caution
Koch says if investors decide to invest for a relatively short period which means two years or less there should be a valid reason for doing so.
“The reason you have this time horizon is because you then want to use the money for something else: school fees, going round the world, a house deposit, or whatever. It would be annoying not to have your starting capital when that time comes,” he says.
Koch says the long-term record of shares is excellent but there is always a risk of a big fall over a short period and there is little protection in picking the most large, stable and ‘safe’ share, because if there is a general market decline, then blue chips will fall in line with the market.
“On the whole, the stock market is not a good place for short-term, ‘hot’ money,” he says.
Do not over-diversify your portfolio
Koch says investors should not over diversify their portfolio and never hold too many stocks as holding more than about 15 stocks does little to decrease risk.
According to Koch, investors should know the companies they invest in extraordinarily well, which is very difficult if they invest in a large number of companies.
“It is better to know a few things rather well, or one thing very well, than it is to know something about a lot of things,” he says.
Koch says another reason for investing in fewer stocks is that inevitably investors will pause longer, think harder and weigh the buy or sell decision more carefully.
“You will also be more vigilant in keeping an eye on them and will stand a much less chance of missing any necessity to sell, lighten or increase your holding. But how many is too many? It depends partly, but only partly, on the amount of time you have for your investments,” he says.
Only invest if you are confident
Koch says before investing it is best to be confident about the medium and long-term prospects for the company.
“You should not invest because you consider the shares ‘a strong bet’. You must first look at the company and assess, by numbers or otherwise, whether it has a good future of growth ahead of it (one good way to assess this is to look at its past). Then you must consider whether the shares are fairly priced, undervalued or overvalued. One of the advantages of having a small portfolio of five to ten stocks is that you will not be tempted to include a few ‘speculative long shots’,” he says.
Never buy on tips
Koch says investors are probably approached from time to time by friends or acquaintances offering them ‘hot tips’ based on rumours, or information close to the ‘inside’ but they should never, ever, buy shares as a result.
“For one thing, it just may be inside information, in which case you and your informant may be committing a criminal offence. But even if the use of insider information was made compulsory it is just not a sensible thing to do. You can’t check the veracity or the importance of the data. In some cases, there may be a deliberate attempt to ‘ramp’ the shares by those who have already bought and plan to sell soon. Tips belong on the race course, and even there they are usually wrong. Avoid them!,” he says.
Do not follow the crowd
Koch says investors should resist the lure of going with a fad as investors could probably beat the majority of investors only by following a different path.
“Stick to your investment strategy for the period you have set and do not be put off by analysts or be seduced by recommendations. You must still convince yourself, of course, that you are right, but, unless you have important new information since you made your original decision, do not be moved,” he says.
Never ‘average down’ when the price is falling
Koch says averaging down is an unsound principle which means adding to holding of a stock, investors already have at a lower price than they previously paid for it, to lower the average acquisition price.
“The price at which you first bought a stock is irrelevant to whether you should buy or sell now. The only issue is whether, with the information you now have, the company has a good future and the shares are undervalued. Only this should impel you to buy, or indeed to hold, a stock: if you cannot confidently say ‘yes’ to the two points above, then sell,” he says.
Koch has the following advice for investors if they are planning to average down –
1. Only average down with extreme caution, and after much deliberation.
2. Do not do it more than once a year.
3. Only do it if you are sure the company’s future is good and the shares are undervalued.
4. Do not allow one stock to take up more than a quarter of the value of your portfolio (this is an absolute maximum, not a target).
5. Never average down more than once for the same stock.
6. Never average down until the price has been stable or rising, with at least one day’s rise, for the previous three days.
Never be afraid to sell at a loss
Koch says some experts believe that investors should always discard the loss makers once they have fallen a predetermined amount.
“If a share has fallen relative to the market as a whole (an important qualification), the onus is on you to say why you should keep it. You must have a good reason for doing so,” he says.
Learn from your experience
Koch says investors personal experience of investment, if analysed carefully, probably will show recurrent patterns of behaviour.
“If you divide your historic portfolio – that is, all the shares you have owned – into three categories, organised by the success or otherwise of the investments, it’s likely that you will gain a lot of insight by asking what is common about all or some of the investments in each category. The aim is for you to categorise your investments as winners, losers and average (in all cases relative to the market), then to look at the winners and find a few common themes about them, either in terms of the types of company, how closely you know them, why you bought them, or any other common factors. Then repeat the process for the other two categories,” he says.
Do not invest heavily when everyone else is doing the same
Koch says investors should not commit a lot of funds to the market when it is reasonably possible that the market is hitting a cyclical high.
According to Koch, one way to avoid this is never to invest when the market is within 3 percent of a record high.
Balance patience and prudence
Koch says there are two opposite schools of thought and approaches that investors can undertake while making an investment decision.
According to Koch one is the ‘long-termist’ approach which holds that there are almost no circumstances in which investors should sell shares in a ‘good’ company.
According to this approach, the trick is to find a few such companies for the long term as an investor and then just stick with them.
Koch says the opposite philosophy is that markets are volatile and no one ever went broke by taking a profit.
“Which you prefer depends on how skilled you are likely to be at identifying even a few good companies. Not many people are good at doing this although, with the right training and encouragement to keep their eyes open, many more could be,” he says.
Koch says the best general position, though, may be three-quarters towards the ‘long term’ view.
Koch lists some guidelines that may help investors make better investment decisions –
1. Do not be too patient with your under-performers.
2. Decide in advance if you have a target selling price above your cost price.
3. Even if the share reaches the target price, continue to hold (nervously) until the shares run out of steam.
4. If you can afford to, do not set a target price and continue to hold your winners for a very long time.
5. If your shares double in value in a short time, and you are thinking of selling, sell only half (or, if you have to, three-quarters) and lock the rest away.
According to Koch, beating the market is both possible and fun.
“If you fail: cut your losses. Hand your money management over to others and enjoy the rest of life. If you succeed, do something worthwhile with at least some of your wealth,” he says.
(Disclaimer: This article is based on Richard Koch’s book The Financial Times Guide to Selecting shares that perform.)